Loading summary
Transcript11 lines
- [00:01]
Host
2024 was a year of transition for economies and global markets. Central banks began easing interest rates, US Elections signaled significant policy change, and generative AI made a quantum leap in adoption and development. Thank you for listening throughout 2024 as we navigated the issues and events that shape financial markets and society. We hope you'll join us next year as we continue to bring you the most up to date information on the financial world this week. Please enjoy some encores of episodes over the last few months and we'll be back with all new episodes in January from all of us at Thoughts on the Market Happy Holidays and a very happy New Year.
- [00:42]
Vishi Tirupator
Welcome to Thoughts on the Market. I am Vishi Tirupator, Morgan Stanley's Chief Fixed Income Strategist. This is part two of our special roundtable discussion on what's ahead for the global economy and markets in 2025. Today we will cover what is ahead for government bonds, currencies and housing. I'm joined by Matt Hornbach, our Chief Macro strategist James Lord, Global Head of Currency and Emerging Market strategy Jay Bachhow, our co head of Securitized Product Strategy and Jim Egan, the other co head of Securitized Product Strategy. It's Tuesday, November 19th at 10:00am in New York. Matt, I'd like to go to you first. 2024 was a fascinating year for government bond yields globally. We started with a deeply inverted US Yield curve at the beginning of the year and we are ending the year with a much steeper curve. With much of that inversion gone. We have seen both meaningful sell offs and rallies over the course of the year as markets negotiated hard landing, soft landing and no landing scenarios. With the election behind us and a significant change of policy ahead of us, how do you see the outlook for global government bond yields in 2025?
- [01:53]
Matt Hornbach
With the US election outcome known, global rate markets can march to the beat of its consequences. Central banks around the world continue to lower policy rates in our Economist baseline projection, with much lower policy rates taking hold in their hard landing scenario versus higher rates in their scenarios for RE acceleration. This skew towards more dovish outcomes alongside the baseline for lower policy rates than captured in current market prices ultimately leads to lower government bond yields and steeper yield curves across most of the G10 through next year. Summarizing the regions we expect treasury yields to move lower over the forecast Horizon, helped by 75bps worth of Fed rate cuts more than markets currently price. We forecast 10 year treasury yields reaching 3.34% by the middle of next year and ending the year just above 3.5%. Our economists are forecasting a pause in the easing cycle in the second half of the year from the Fed that would leave the Fed funds rate still above the median longer run. The rationale for the pause involves Fed uncertainty over the ultimate effects of tariffs and immigration reform on growth and inflation. We also see the treasury curve bull steepening throughout the forecast horizon, with most of the steepening in the first half of the year when most of the fall in yields occur. Finally, on break even inflation rates, we see 5 and 10 year breakevens tightening slightly by the middle of 2025 as inflation risks cool. However, as the Trump administration starts implementing tariffs, breakevens widen in our forecast with the 5 and 10 year maturities reaching 2.55% and 2.4% respectively by the end of next year. As such, we think real yields will lead the bulk of the decline in nominal yields in our forecasting with with the 10 year real yield around 1.45% by the middle of next year and ending the year at 1.15% that's very helpful.
- [03:49]
Vishi Tirupator
Matt James clearly the incoming administration has policy choices and their sequencing and severity will have major implications for the strength of the dollar that has rallied substantially in the last few months against this broad drop. How do you assess 2025 to be? What differences do you expect to see between DiEM and EM currency markets?
- [04:10]
James Lord
The incoming administration's proposed policies could have far reaching impacts on currency markets, some of which are already being reflected in the price of the dollar today. We had argued ahead of the election that a Republican sweep was probably the most bullish dollar outcome and we are now seeing that being reflected. We do think the dollar rally continues for a little bit longer as markets price in a higher likelihood of tariffs being implemented against trading partners. Our risk of additional deficit expansion in 2025 however, we don't really see that dollar strength persisting for long throughout 2025. So I think that is compared to the current debate, compared to the current market pricing a negative dollar catalyst that should get priced into markets. And to your question Vishy, there will be differences with EM and also within EM as well. Probably the most notable one is the renminbi. We have the renminbi as the weakest currency within all of our forecasts for 2025 really reflecting the impact of tariffs. We expect tariffs against China to be more consequential than against other countries, thus requiring a bigger adjustment. On the FX side we see dollar China or dollar renminbi ending next year at 7.6 so that represents a very sharp divergence versus dollar yen and the broader DXY moves and is a consequence of tariffs. And that does imply that the Fed's broad dollar index only has a pretty modest decline next year despite the bigger move in the Dixie. The rest of Asia will likely follow dollar China more closely than dollar yen in our view causing AXJ currencies to generally underperform versus CMIA and Latin America, which on the whole do a bit better.
- [05:52]
Vishi Tirupator
Jay in contrast to corporate credit, mortgage spreads are at or about their long term average levels. How do you expect 2025 to pan out for mortgages? What are the key drivers of your expectations and which potential policy changes you are most focused on?
- [06:09]
Jay Bachhow
As you point out, mortgage spreads do look wide to corporate spreads, but there are good reasons for that. We all know that the Fed is reducing their holdings of mortgages and they're the largest holder of mortgages in the world. We don't expect Fed balance sheet reduction of mortgages to change even if they do end QT as is our forecast in the first quarter of 2025. When they end QT, we expect mortgage runoff to continue to go into Treasuries. What we do expect to change next year is that bank demand function will shift. We are working under the assumption that the Basel III endgame either stalls under the next administration or gets released in a way that is capital neutral and that's going to free up excess capital for banks and reduce regulatory uncertainty for them in how they deploy the cash in their portfolios. One thing that we've been waiting for is this clarity around regulations. When that changes, we think that's going to be a positive. But it's not just banks returning to the market. We think that there's going to be tailwinds from overseas investors that are going to be hedging out their FX risks as the Fed cuts rates and the bank of Japan hikes. So we expect more demand from Japanese life insurance companies. A steeper yield curve is going to be good for REIT demand. And these buyers, banks overseas REITs, they typically buy cusips and that's going to help not just from a demand side, but it's going to help funding on mortgages improve as well. And all of those things are going to take mortgage spreads tighter and that's why we are bullish. I also want to mention agency CMBS for a moment. The technical pusher there is even better than in single family mortgages. The supply story is still constrained, but there is no Fed QT in multifamily and then also the capital that's going to be available for banks from the deregulation will allow them, in combination with the portfolio layer hedging, to add agency cmbs in a way that they haven't really been adding in the last few years. So that could take spreads tighter as well. Now Vishy, you also mentioned policy changes. We think discussions around GSE reform are likely to become more prevalent under the new administration. And we think that given that improved capitalization, depending on the path of their earnings and any plans to raise capital, we could see an attempt to exit conservatorship during this administration. But we will simply state our view that any plan that results in a meaningful change to the capital treatment or credit risk to the investors of conventional mortgages is going to be too destabilizing for the housing finance markets to implement. And so we don't think that path could go forward.
- [08:36]
Vishi Tirupator
Thanks, Jay Jim, it was a challenging year for the housing market with historically high levels of unaffordability and continued headwinds of limited supply. How do you see 2025 to be for the US housing market and going beyond housing? What is your outlook for the opportunity set in securitized credit for 2025?
- [08:55]
Host
For the housing market, the 2025 narrative is going to be one about the absolute level versus the direction and rate of change. For instance, Vishy, you mentioned affordability. Mortgage rates have increased significantly since the beginning of September, but it's also true that they're down roughly 100 basis points from the fourth quarter of 2023. And we're forecasting pretty healthy decreases in the 10 year treasury throughout 2025. So we're we expect affordability to improve over the coming year supply. It remains near historic lows, but it's been increasing year to date. So similar to the affordability narrative, it's more challenged than it's been in decades, but it's also less challenged than it was a year ago. So what does all this mean for the housing market as we look through 2025? Despite the improvements in affordability, sales volumes have been pretty stagnant this year. Total volumes, so existing plus new volumes are actually down about 3% year to date. And look, that isn't unusual. It typically takes about a year for sales volumes to pick up when you see this kind of significant affordability improvement that we've witnessed over the past year, even with the recent backup in mortgage rates. And that means we think we're kind of entering that sweet spot for increased sales. Now we've seen purchase applications turn positive year over year. We we've seen pending home sales turn positive year over year. That's the first time both of those things have happened since 2021. But when we think about how much sales volumes can grow in 2025, we think it's going to be a little bit more curtailed. There are a whole host of reasons for that, but one of them the lock in effect. It's been a very popular talking point in the housing market this year. If we look at just the difference between the effective mortgage rate on the outstanding universe and where you can take out a mortgage rate today, the universe is still over 200 basis points out of the money to the upside. You're not going to get 10% growth there, but you're going to get more than 5% growth in new home sales. And what I really want to emphasize here is yes, mortgage rates have increased recently. We expect them to come down in 2025. But even if they don't, we don't think there's a lot of room for downside to existing home sales from here. There's some level of housing activity that has to happen regardless of where mortgage rates or affordability are. We think we're there. Turnover measured as the number of transactions, existing transactions as a share of the outstanding housing market is lower now than it was during the great financial crisis. It's as low as it's been in a little bit over 40 years. We just don't think it can fall that much further from here. But as we go through 2025 we do think it dips negative. We have a negative 2% HPA call next year. Not significantly down. We don't think there's a lot of room to the downside given the healthy foundation, the low supply, the strong credit standards in the housing market. But there is a little bit of negativity next year before home prices re accelerate. This leaves us generically constructive on securitized products across the board. Given how much the capital structure has flattened this year. We think CLO AAA's actually offer the best value amongst the debt tranches there. We think non QM AAA's if agency MBS is going to tighten, they look cheap to IG corporates. Consumer ABS we also think still looks pretty cheap to IG corporates. Even in the CMBS pace we think there's opportunities. CMBS has really outperformed this year as rates have come down. Now our bull bear spread differentials are much wider in cmbs than they are elsewhere. But in our base case conduit BBB minuses still offer attractive value. That being said, if we're going to go down the capital structure, our favorite expression in the securitized credit space is US CLO Equity.
- [12:26]
Vishi Tirupator
Thank you Jay and Jim and also Matt and James. We'll close it out here. As a reminder, if you enjoy the show, please leave us a review wherever you listen and share thoughts on the market with a friend or colleague today.
- [12:39]
Matt Hornbach
The preceding content is informational only and based on information available when created. It is not an offer or solicitation, nor is it tax or legal advice. It does not consider your financial circumstances and objectives and may not be suitable for.